Moody's Warns Of U.S. Rating Downgrade Without Budget Deal

9/11/2012 2:18 PM ET

Leading credit ratings agency Moody's Investors Service warned Tuesday that the U.S. could face a ratings downgrade if Congress fails to reach an agreement to address the federal deficit in the next year.

Moody's currently has a Aaa rating on U.S. government debt with a "negative" outlook, which was imposed after last year's fight over raising the debt limit.

The agency said that the ratings outlook would be returned to "stable" if budget negotiations lead to policies that produce a stabilization and then downward trend in the ratio of federal debt to GDP over the medium term.

Moody's warned that it would expect to lower the rating to Aa1 if the negotiations fail to produce such policies during the 2013 Congressional legislative session.

Last year, the drawn out debate over raising the debt limit led rival ratings agency Standard & Poor's to cuts its rating on U.S. debt to AA+ from AAA.

Moody's said the U.S. is unlikely to maintain a Aaa rating with a negative outlook into 2014 unless the method adopted to achieve debt stabilization involved a large, immediate fiscal shock such as the upcoming "fiscal cliff."

The agency said it would then need evidence that the economy could rebound from the shock before it would consider returning to a stable outlook.

While Moody's said that the Aaa rating with a negative outlook is likely to be maintained until the outcome of budget negotiations becomes clear, it noted that the outlook assumes a relatively orderly process for the increase in the statutory debt limit.

The U.S. is expected to reach the debt limit by the end of the year, and it remains to be seen if Congress will wage another long battle over raising the limit once again.

Commenting on the statement from Moody's, House Speaker John Boehner, R-Ohio, said, "Today's warning by Moody's underscores the point we have been making all year: the threat to American jobs comes not from action on our debt, but from inaction on our debt."

"People in both parties know what needs to be done to free our economy from the destructive debt that is blocking robust growth: we need to fundamentally reform our tax code, reduce spending, save Medicare, and reform other critical programs that are heading toward bankruptcy," he added.

Boehner blamed the Democratic-controlled Senate for failing to take up House-passed budgets that would "achieve these pro-growth goals," while Democrats have pointed the finger back at Republicans for refusing to take a "balanced approach" to reducing the deficit.

Meanwhile, a research note from Capital Economics said that the warning from Moody's is not "new news" and said it shouldn't cause any major waves in the bond market.

"The U.S. fiscal position has been on a perilous trajectory for some years and S&P downgraded America's credit rating last year," Capital Economics said. "Nevertheless, the U.S. can still borrow at historically cheap rates."